Lower public spending leads to more jobs

Over the next year or so the question of which countries best survived the bust is likely to be a major source of argument. Supporters of high taxes are already pointing to predictions that low-tax countries such as Ireland are going to suffer badly, with larger than average falls in GDP and increasing unemployment.

 

But to look just at the bust misses most of the picture. We need to take a long-term view, ten years or more, and see how economies performed in the boom and how much they managed to hang onto in the bust.

 

One of the most important practical measures of an economy’s success is jobs – how many people are able to find work. And on that basis the low-tax countries did very well in the boom. Looking at the EU, and comparing the growth in employment to the percentage of GDP that the government spends (the true long-term measure of the tax rate), we see (as expected) a clear trend that lower taxes lead to more jobs:

Source: Eurostat, pre-2007 EU Member States

 

The trend is clear – lower levels of government spending (and hence taxation) resulted in stronger employment growth.

 

There is also a clear cut-off at 42%:

  • All the countries whose government spent less than 42% of GDP increased the number of people in employment by 10% or more (and usually a lot more).
  • None of the countries whose governments spent 42% or more of GDP managed to grow their employment by more than about 10% over that period, with just one exception (see below).

The sole exception was Italy, with the government apparently spending 48% of GDP but still managing 12% jobs growth. However Italy’s massive shadow economy (estimated at 27% of the observed economy) makes its GDP figures particularly unreliable. If Italy’s true GDP (including the shadow economy) is just 15% higher than the recorded amount, then its government spending is actually less than 42% of GDP, putting it on the left hand side of the graph.

 

Overall the lower taxed countries increased their employment by almost 27% between 2000 and 2008, while the higher taxed countries increased theirs by barely 6%.

 

And this is not just a matter of growth in the “new Europe” countries outstripping the long established EU members. If we separate the countries into “old” and “new” EU members, the same relationship between low taxes and high job creation is clear in each group.

 

We shall see over the next couple of years how the various countries weather the storm of the recession. But even if the lower taxed countries lose more jobs in the downturn, their strong performance from 2000 to 2008 makes it very likely that they will still overall have created more sustained jobs than their higher taxed fellows.

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